Wall Street’s New Trend: How to Play Tax Inversion Mergers

A new trend is developing on Wall Street. American companies are looking to merge with overseas companies in order to move corporate headquarters to reduce corporate tax rates. With America’s corporate tax rate sitting at a punitive 35 percent and with several European countries boasting low corporate tax rates — sometimes half of this level or lower — this is a very attractive move for American companies.

For instance, a company that earns $1 million before taxes earns $650,000 after taxes. If we put a 15 price-to-earnings multiple on this figure, the company’s valuation is $9.75 million. But if the company moves to Ireland — a popular tax inversion jurisdiction where the corporate tax rate is just 12.5 percent — the compay’s earnings jump to $875,000 and the same 15 price-to-earnings multiple brings the stock’s valuation up to $13.1 million: a whopping 35 percent higher! Not only that but the company now has $225,000 to invest, this means that it can grow faster. No wonder companies want to do this.

Covidien (NYSE:COV) was the latest acquisition target, but now we are seeing that AbbVie (NYSE:ABBV) – an American pharmaceutical company — is interested in acquiring Shire (NASDAQ:SHPG) — another Irish company. We are also seeing interest in Walgreens (NYSE:WAG), which wants to buy Alliance Boots — a European drugstore chain. While the President and the Treasury Department are sabre-rattling, the fact remains that remaining incorporated in the United States makes little sense so long as taxes are so high, especially since there is a loophole for corporations to renounce their “citizenships.”